WISE MONEY

Uncertainty about Ireland’s debt crisis has helped support the dollar recently as markets remain focused on Ireland’s financial woes. Eurozone ministers have screwed the Irish into accepting a joint European-IMF mission to Ireland that could prepare the way for a bailout to prevent its debt crisis spreading to other countries.

Currencies are see-sawing as year end book closing has prompted a lot of short dollar positions built up over the past couple of months to unwind, exacerbating losses in the euro.

The Pound could come under pressure should Ireland resist assistance given UK banks’ large exposure to the country.

Sterling edged up against the dollar and euro on Wednesday after an unexpected fall in jobless benefit claims and as the Bank of England showed it had held its three-way split at its latest policy meeting.

Data showed the number of Britons claiming unemployment benefit fell by 3,700 in October, the first fall since July and confounding expectations for a rise of 5,000.

Separately, minutes from the Nov 3-4 BoE Monetary Policy Committee meeting showed one member wanting more stimulus, another voting for a rate hike and the remaining seven keeping policy on hold and ready to act in either direction.

That was likely to reinforce expectations policy would remain on hold well into next year until the outlook for the economy became clearer.

Dominique Strauss-Kahn the IMF’s Managing Director said co-operation between countries had weakened since the financial crisis started in 2008.The Fed’s policies have led to a wave of money-seeking opportunities in the emerging economies. That tends to push their currencies up, undermining their competitiveness.

There is also the risk of bubbles in financial and property markets. And capital inflows can go into reverse – as they did in the Asian crisis in the 1990s.

So the third element in the currency “war” is the resistance of emerging economies, and some developed ones too.

Brazil and Thailand have used tax measures to slow the inflows. Japan, South Korea and others have intervened in the currency markets, buying foreign currency in an attempt to interrupt the rise of their own.

There is a view that they will just have to live with it. The upward pressure on the currencies of many emerging economies reflects the fact they are more growing strongly than the US.

It is difficult for them to manage, but the underlying reason is that they are doing relatively well.

The currency war is closely linked with another theme that has been troubling many economists for several years, that of global economic imbalances.

In international terms, it is trade that is unbalanced. Actually, the thing that is most often the focus is the “current account balance”, which means trade in goods and services plus some financial items, including remittances that migrant workers send home.

Usually, though, trade is responsible for most of the current account imbalance.

Some countries have large trade surpluses, notably China, Germany, Saudi Arabia and Russia. The biggest deficit country is the United States.

Some countries at the eye of the European storm have hefty deficits too – the PIGS aka Portugal, Ireland, Greece and Spain.

Britain also has a deficit, although as a share of national income, it is not all that large.

The other side of international imbalances is high savings at home with a surplus country such as China, and relatively low savings in a deficit country such as the US.

Household savings have risen in the US, the UK and other deficit countries, because consumers are borrowing less in the wake of the financial crisis.

But international imbalances also reflect how much governments borrow and in many deficit countries that has risen, partly offsetting the increase in private savings.

Why does all this matter? Those countries where saving has risen desperately want to export more. They want to sell more abroad to make up for consumers at home drawing cutting back their consumption.

That is true of the US, Britain and many others. They could do that more easily if consumers in China and the other surplus countries were willing to buy more imported goods.

A rise in China’s currency would not be a cure all, but it would probably help in the short term. Although it would also create greater inflation.

It has been called a “currency war”, by the International Monetary Fund’s managing director and the Brazilian finance minister among others.
IMF chief Dominique Strauss-Kahn warned that there were signs that countries were trying to use their currencies “as a weapon”.

For his part, Brazil’s Guido Mantega said competitive devaluations by advanced countries amounted to a new trade war.

“We’re in the midst of an international currency war,” he told a meeting of industrial leaders in September. “This threatens us because it takes away our competitiveness.”

There are three key elements, two of them fairly new, but the first is a long standing one.

It is China’s policy of managing its currency and limiting its movement against the US dollar.

It has been though several phases and during the financial crisis, China went back to keeping the yuan from rising.
Clerk counting 100-yuan notes China is trying to hold the yuan’s value down

Since just before the Toronto G20 summit in June, it has eased the controls and allowed the currency to move up against the dollar, but by less than 2.5% (as of now). And because the dollar has fallen, the yuan has dropped against many other currencies as well.

The reason for the Chinese reluctance to allow the yuan to rise much is a fear of job losses among export industries that would be made less competitive.

The rise against the dollar has not been enough to satisfy the US, where there is a long standing complaint that China manipulates its currency to gain an unfair advantage. The cry is: “It costs American jobs.”

Many in the US complain about China, but they are not innocent either.

The dollar has fallen sharply in recent months, because interest rates are low, so investors have been seeking higher returns in emerging economies.

They need to buy the currency of the country concerned to make those investments. That tends to push its value up, while the dollar, which they are selling, tends to fall.

And the effect is aggravated by the Federal Reserve’s other policy, known as quantitative easing. The Fed buys financial assets and the money it pays with has to be invested somewhere.

The weak dollar has an advantage for the US – it’s that competitiveness issue again. It should help American exporters.

The US has a large trade deficit, so more exports could help fix that. Many argue that the Fed’s policies are actually intended to weaken the dollar and help the US economy recover by exporting more.

The Fed’s policies have led to a wave of money-seeking opportunities in the emerging economies. That tends to push their currencies up, undermining their competitiveness.

There is also the risk of bubbles in financial and property markets. And capital inflows can go into reverse – as they did in the Asian crisis in the 1990s.

The International Monetary Fund says the global financial system remains the problem area for the economic recovery.In a new report, the IMF predicts a gradual improvement in the financial system, but adds that there is a substantial risk of further problems.

The warning is not one of panic, but they are clearly nervous.

The IMF says that in the last six months there has been a setback to financial stability, which may affect the recovery from global recession.

That has been highlighted by the continuing turmoil in European financial markets. In these markets, government debt has combined with the weak banks to undermine stability.

Jose Vinals, the senior IMF official responsible for the report, said that some of the most vulnerable countries have taken important steps to deal with government debt and problem banks.

Greece is moving “forcefully” and Ireland is taking “very decisive actions”, he said.  So he expects “things to get better not worse”, he said.

Nonetheless, the financial system remains fragile, the report warns.

There is also a warning that some developing countries could be destabilised by large financial inflows, as investors seek higher returns in fast-growing economies. That is particularly a concern in Asia and Latin America.

One important theme underlying this report is the continued divergence between the unconvincing economic recovery in rich countries and the more robust performance of many developing nations.

Low interest rates in the developed world, intended to spur recovery, mean there may be more money to be made in Asia and Latin America.

The IMF points out that quite modest shifts by rich country investors could have a large impact on developing-world financial markets.

Such inflows have the potential to lead to financial instability.

The latest GDP figures for the UK were released this morning showing a rise of 1.2% QoQ for the 2nd month in succession leading to a strong start for Sterling against its rivals. The leading indicator of economic health also illustrated an increase of 1.7% YoY painting the picture that the UK economy is steadying and looking at sluggish, but stable growth.

The news has kept the Pound above 1.58 against the Dollar, but also seen it bounce back over 1.18 in trading vs the Euro.

This has also been on the back of comments from the IMF and the Bank of England.

Firstly, the International Monetary Fund endorsed Chancellor George Osborne’s deficit reduction plans stating that the UK was “on the mend” and added the plan “greatly reduces the risk off a loss of confidence in public finances and supports a balanced recovery”.

Secondly, BoE Deputy Governor Charlie Bean said the central bank wanted households to “spend more rather than save”.

The Euro has taken a small hit this morning as Moody’s announced it was slashing the ratings of Anglo Irish’s debt, unnerving investors as Dublin tots up the final cost of rescuing the lender whose loans have crippled the Irish economy.

Government bond spreads between Germany and the struggling nations of Europe have widened again leading to more fears over the Eurozone debt situation.

Eurodollar is down a cent, which will bring relief to all exporters to the US as the pairing runs up against stronger resistance; it has been sitting on 5 month highs.

On Friday, the Dow Jones fell by as much as 120 points after annualised growth in gross domestic product (GDP) was found to have slowed from 3.7% in the first quarter to 2.4% in the second.That came on the back of growth of 5% in the final three months of 2009. The US was initially thought to have grown by 2.7% in the first quarter but that was revised upwards on a day of surprises for economists.

The US Commerce Department also revised downwards GDP figures all the way back to the beginning of 2007.

The second-quarter slowdown led economists to question whether the US might be poised to enter a period of negative growth later in the year, leading to a much-feared double-dip recession.

The Dow Jones fell sharply after the release of the GDP data before recovering ground to settle down 40.72 at 10,426.44 in lunchtime trading. Economists had predicted second-quarter growth of 2.5pc, but their disappointment was compounded by the revised data for the first three months of 2010.

The biggest concern in the City was the size of the downward revisions to previous years’ growth. In 2009 the economy was previously estimated to have declined by 2.4%, but the figure was revised to a drop of 2.6%.

The disappointing growth numbers were compounded by the International Monetary Fund’s (IMF) annual report on the US economy. The IMF said there may be a need for the Obama administration to increase the amount of fiscal stimulus in order to boost the recovery, warning the “outlook remains uncertain”.

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This week is all about the euro and the approaching stress test results which will offer much needed feedback on the health of European banks.
The euro has experienced a significant turn of fortune from its June 4 and half low against the USD gaining over 10 cents to test the 1.30 level.

One reason that the euro has gained is simply that the market was significantly over short in the euro and naturally a lot of these short investors paired their positions leading to a short squeeze higher.

In addition some comfort has come back into the euro approaching Fridays stress test results as comments in the run up from members of the IMF and the ECB have been bullish – we will see!

Recent gains have led to EUR/USD testing the 1.30 level and GBP/EUR falling back into 1.17 territory. The results are due out from 5pm GMT on Friday- good feedback should push EUR/USD over 1.30.

An unnamed bank or banks had lent 380 tonnes of gold to the Bank of International Settlements in return for foreign currencies causing widespread surprise and confusion.
The news that a mystery bank has just pawned the family jewels gave traders a jolt – nervous about the sudden transfer of almost 20pc of the world’s annual gold production and the possibility of a sell-off.

In a tiny footnote in its annual report, the BIS disclosed its unusually large holding of gold, compared with none the year before. The disclosure was a large factor in the correction of the gold price this week, which fell below $1,200 for the first time in more than a month.

Concerns hinged on whether the BIS could potentially sell on this vast cache of bullion in the event of a default, flooding the market with liquidity.

It appears to have raised $14bn for whoever’s been doing the swapping – small fry on the currency markets, but serious liquidity in the gold market.

Denominated in euros, gold has fallen 8pc since the beginning of the month and is now trading at a seven-week low of €937 per troy ounce.

The big gold exchange traded funds (ETFs) – having peaked at record inflows in May – have also been showing net outflows over the past few days.

Meanwhile, economists and gold market-watchers were determined to hunt down which bank is short of cash – curious about who is using their stash of precious metal for what looks suspiciously like a secret bailout.

At first it looked like the BIS was swapping gold with a troubled central bank. After all, the institution is the central bankers’ bank and its purpose to conduct transactions with national monetary authorities.

Central banks in the troubled southern zone of Europe were considered the most likely perpetrators.

According to the World Gold Council, central banks in Greece, Spain and Portugal held 112.2, 281.6 and 382.5 tons of gold respectively in June – leading analysts to point fingers at Portugal, or a combination of the three.

The only other potential monetary authorities with enough gold as the US, China, Switzerland, Japan, Russia, India and Taiwan – and the International Monetary Fund.

This led to musings that the counterparty was the IMF, making sense because the lender of last resort is historically prone to cash shortages and has been quietly selling off gold in the first half of the year.

Renowned gold expert Jim Sinclair adopted this explanation. The panic came when people mistook a lease for a swap, he argues. Far from being a big release of gold into the market, it is simply a commercial arrangement between the IMF and BIS with a favourable rate of interest paid for the foreign currency.

“Gold swaps are usually undertaken by monetary authorities,” he writes on his industry blog, JSMineSet. “The gold is exchanged for foreign exchange deposits with an agreement that the transaction be unwound at a future time at an agreed price.

“The IMF will pay interest on the foreign exchange received. Historically swaps occur when entities like the IMF have a need for foreign exchange, but do not wish to sell the gold. In this case, gold is a leveraging device for needed currency to meet requirements.

“The many reports that characterise the large IMF gold swap as a sale of gold into the markets do not understand the difference between a swap and a lease.”

However, the day after original reports about the swaps, BIS emailed a statement saying that the swaps had not been conducted with monetary authorities but purely with commercial banks.

This did nothing to quell the sense of mystery surrounding the deal or deals. It is almost inconceivable that a single commercial bank could have accumulated so much gold alone. And cynics have suggested that the whole affair still looks like a secretive European bailout that a single country wants to keep quiet.

In this case, one or more of the so-called bullion banks – which act as wholesale market-makers and include Goldman Sachs, Deutsche Bank, JP Morgan, HSBC, Barclays, UBS, Societe Generale, Mitsui and the Bank of Nova Scotia – would have agreed to act on behalf of a monetary authority.

The euro hit a two month high against the US Dollar before running into large selling resistance and falling back towards 1.25. Although German manufacturers posted some impressive sales figures at the end of last week and boosted confidence in the continuing Eurozone economic recovery, fears over manufacturing and unemployment data in periphery member nations is swamping any and all positive news from Germany.

Added to the muted response to the Stress test methodology there is enough news around the keep the Euro suppressed for the next few days.

Sterling fell below the key 1.50 level over the weekend as fears over the UK economic recovery remerged. The IMF’s warning that spending cuts and tax increases announced by the coalition Government will reduce future growth levels has pushed the pound lower against the Dollar and Euro, but the key driver of the Sterling sell off seems to be technical.

Failure to break through the 1.5260 level signalled to traders to realise profits, sending the Pound lower.

We will get a clearer picture of the current economic climate in the UK this week, with the release of the delayed GDP figures and inflation and unemployment data.

Asian stock markets fell today and the euro and sterling hovered near the lows they reached yesterday as concerns persisted over Europe’s debt worries.The Nikkei index in Japan fell 98.81 points, or 1 per cent, at 9,439.13 to record its lowest close for six months after earlier falling as far as 9,378.23. Japan’s export-led economy is dependent on demand from Europe.

Asian investors were also jolted by a warning from the International Monetary Fund that the European sovereign debt crisis could spill over to Asia.

Naoyuki Shinohara, the IMF deputy managing director, told a forum in Singapore: “Adverse developments in Europe could disrupt global trade, with implications for Asia given the still important role of external demand.”

He also warned that although Asia’s bright growth prospects were currently attracting capital, “further increases in global risk aversion could see capital flows change direction quickly.”

Investors were also unsettled by comments by the ratings agency Fitch that Britain faced a “formidable challenge”.

However after currency trading began in London this morning both the euro and sterling edged up slightly against the dollar. The euro rose nearly a cent from yesterday’s four-year low of $1.1876 to $1.1967 while the Pound improved by half a cent to $1.4462.

Traders and analysts said that the focus was on the European Central Bank (ECB) to shore up sentiment.

In a further sign that investors were seeking cash the Bank of England’s latest offer to buy corporate bonds from banks was met by record demand this week. Banks tried to sell £507 million of bonds, the highest since the Bank of England began its bond buy-back programme in February last year as an attempt to restore confidence in the midst of the financial crisis.

The price of gold reached $1,236 an ounce, within sight of yesterday’s record high of $1,250.